Freemium has run its course

“We are now seeing the end of the freemium model — signing up users for free and trying to upsell,” said Christian Vanek, CEO of the Boulder-based SurveyGizmo, in a recent phone conversation.

“6.5 million unique users is not all that it’s cracked up to be. I don’t want hits. I want revenue. I want a real business,” said Matt Wensing, founder and CEO of Stormpulse, in an interview withMixergy.

“Make a product people want to pay for,” said Marco Arment, founder of Instapaper, in a Planet Money interview.

Three easily available examples do not make indisputable evidence against freemium. Just like Dropbox, Evernote and RememberTheMilk do not make a case for freemium. But these three quotes reflect a return to the roots of marketing — starting with customer needs, choosing the needs you want to serve and getting your fair share of the value created.

In the oft-cited Hershey’s experiment that started the free-mania, behavioral economists from MIT tested customer preference for Hershey’s and Ferrero Rocher chocolates at two different price points. For one group, they offered Hershey’s at one cent and Ferrero Rocher for 26 cents. For another, they offered the chocolates at zero cents and 25 cents respectively. When the Hershey’s chocolate was free and the Ferrero Rocher chocolate was 25 cents, 90 percent of the participants chose Hershey’s. $ 0 price seems to have done the magic in driving customer adoption. The result became the foundation of the freemium school of thought — free is free marketing. First use the free version to drive adoption and build a large customer base, and then find ways to monetize that base by upselling the paid version and selling extras.

Ninety percent is an eye-catching statistic in books about the freemium model, but let’s stop and ask some basic questions about running a profitable venture.

What do you know about your target customers?

What urgent needs do the free and paid versions meet for these customers?

Will the products remain relevant in the customers’ future?

If fifty other sellers stand next to you and give away free Hershey’s chocolates, Skittles etc., what will happen to your share of the market?

As a startup founder, which customers should you focus on first with your limited resources?

The five questions above are the key principles of marketing. Unfortunately, choosing a freemium model does not help answer these questions. Worse, it muddles the answers by misdirecting startup founders to focus on the product rather than customer needs. Stormpulse, a Web-based platform for managing weather risk, learned that free can attract all the wrong customers. The company’s CEO Matt Wensing told Mixergy, “Free brought us recreational users who tried us for superficial reasons, while those who found real value were the enterprise customers.”

Here is an alternative, which unlike freemium is neither new nor a fad:

Start with the customers, not your product. The product could be new but the customer needs are not. Whether it is a “bits” product with zero marginal cost or “atoms” product with non-zero marginal cost, customer needs come first.In fact, it is not a product until you have identified a set of customers whose needs you meet and who want to pay you for that value.

Make your choice. Stormpulse and the online survey platform, SurveyGizmo, both realized that a successful strategy involves making choices. They couldn’t go after every customer who is willing to try out their products. Instead, the leaders at both organizations chose to focus on enterprise customers, because these customers not only value the products but also have the budget to pay for them. Getting 90 percent of customers to take free Hershey’s chocolates with the hope that they will pay more for extras or will upgrade later is not a strategy. In fact, the presence of free products drags down the expected value of a customer. Which is another reason why SurveyGizmo decided to downplay its free offering.

Get your fair share of the value created. As Instapaper’s Arment said, charging for the product is still the simplest of all business models. Product innovation does not mean business model innovation. If your product adds compelling value to customers, charging for it is simply getting your fair share of the value created. You do not have to be ashamed of making a profit.

A small percentage of a very large number is indeed a large number, but can your startup stay solvent while you wait for the conversion to kick in? Freemium only offers the hope that non-paying users will fall in love with your product and start paying for it. Shooting an unlimited number of free bullets and hoping some will hit the target is a shotgun approach to monetization. It’s time to take a deliberate and targeted approach. Or as Vanek told me in our conversation, “it is time to retire the shotgun.”

Rags Srinivasan is a management professional who specializes in product strategy and strategic marketing. He is currently working on big data products. He blogs at Iterative Path and tweets at @rags

Feature image courtesy of Flickr user ColinGordon

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